Data and Reporting

Credit card processing explained: how it works, why it costs money, and how to get the best deal

Credit card processing is a basic need for most businesses today, and there’s no way to avoid paying for it. But if you’re smart about picking your payments partner, the benefits will far outweigh the costs.

A lot of small business owners have a love-hate relationship with payment processing. Sure, it helps them make money, but it also costs money. They love the convenience of taking customers’ credit cards for payment, but they hate dealing with all the behind the scenes aspects of working with a credit card processor. From picking a provider, to getting things up and running, to troubleshooting problems and growing into the future, there are a lot of things to consider.

Credit Card Processing

Accept all payment types

Make sure your customers can pay any way they want, whether it’s with a rewards card, a mobile phone, or an EMV chip card.

Sell on demand

Make it easy for customers to buy wherever they want including in-store, in-app, and online. You’ll capture more revenue and loyalty.

Speed up checkout

Bring the terminal to the customer so you can shorten lines, serve more customers and deliver an added touch to the checkout experience.

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As a business owner, how do you choose a processor that won’t break the bank, but also won’t leave you in the lurch when the chips are down? Follow along, and we’ll cover everything you ever wanted to know about credit card processing and how to get the most value for the best price.

Potential value

When you have smart payments technology for your business, and the right credit card processing partner you could experience substantial benefits including:

Increased sales volume and higher tickets –Consumers spend 12-18 percent more when they use credit cards instead of cash.

Streamlined back office operations—payments technology can help you operate more efficiently by connecting to and enhancing other business management solutions.

Strong payments security –a reputable credit card processor can help ease the burden of security regulations and risks that every business owner faces.

System scalability—expanding your business shouldn’t present a technology challenge. With the right partner, your payments solution can grow along with your business.

Accountability—getting the support you need when you need it is crucial, so make sure your processor has a good reputation for their responsiveness and reliability.

Customization—every business is unique and with the right partner, you’ll have the flexibility to tailor the perfect solution.

How credit card processing works

Credit card processing is defined as using an electronic system to move money from a customer’s bank (issuing bank) into a merchant’s bank (acquiring bank) as payment for goods and/or services. A payment processor is required in order to facilitate this process of requesting, verifying, and then transferring funds.

It seems pretty straightforward and simple. But behind the scenes is a massive network of moving parts that keeps card payment transactions flowing. Knowing your way around those systems and the individual factors that impact you as the end user can help you get the best value.

Payment platforms

In order to run payment transactions, merchants have to have a connection to a payment platform. Platforms come in four basic categories:

Direct

Gateway

eCommerce

PayFac

The right platform for you depends on several factors including the way you accept payments, volume of transactions you run, the add-on features you want, and the level of service you need.

Direct payment platform

A direct payment platform is owned and operated by the merchant services provider on the front side (where a customer swipes the card) and on the back end (where the payment gets authorized and settled). Vantiv, for example, owns the payment platform we operate, meaning we perform every part of the transaction process for merchants on our direct platform.

Gateway platform

A gateway platform is when a merchant services provider borrows another third-party platform to handle the back end of the transaction. They do business as a payments processor with their own name, but create a “gateway” to access a third party provider’s platform to settle transactions on the back end. A gateway can enable merchants to use a particular processor’s services even if they don’t have a direct integration to that platform.

PayFac platform

PayFac is short for “payment facilitator,” and allows merchants to process payments without having a traditional merchant services account. PayFacs enroll multiple merchants on a single master account. This way, individual businesses called “sub-merchants,” don’t have to sign up for their own credit card processing account. Instead they enroll with and are underwritten directly by the PayFac with some security checks by the processor. The payment processing piece is just one aspect of a wider service. One example of a PayFac is Etsy, the online small business market. Merchants doing business via Etsy can instantly accept payments as part of the larger Etsy service.

eCommerce platform

An eCommerce platform is needed to facilitate the card-not-present transactions necessary to operate an online business. Large eCommerce operations need a dedicated eCommerce platform, but smaller businesses and those merchants offering online transactions in addition to their core in-store business can use a shopping cart add-on service. A shopping cart, or hosted checkout solution operates similarly to a gateway by providing access to a back end processing platform.

You’re going to need a device

Regardless of the platform, processing payments requires some type of card acceptance device to get the credit card information into the authorization network for approval. The most common device is a payment terminal with PIN pad. Standard PIN pad terminals have a magnetic stripe reader and many also have an EMV chip card reader to process chip cards. Merchants operating on gateways and direct platforms tend to use these types of terminals. PayFac merchants tend to use smaller dongle-based terminals that plug into a mobile device for on-the-go payment processing.

For larger businesses and certain industries like restaurants, a popular payment device is an integrated point of sale (POS) system, which performs a variety of business operations such as menu management, employee timekeeping, inventory control, and accounting in addition to payment processing. The term “integrated” refers to the specific compatibility of the POS system and the platform, which offers particular benefits to these merchants.

Why credit card processing costs money

The first thing to know about payment processing fees is that the “rate” you pay is really a combination of three separate charges that sometimes get rolled into one for simplicity. Luckily, the merchant usually only has to directly pay one entity—the processor—who collects the fees and pays the card brands and card networks on the merchant’s behalf.

The three charges include 1. interchange, which goes to the card processing network, 2. assessments, which go to the card brands (Visa, MasterCard, etc.), and 3. value-added fees which go to the payment processor.

A word of caution about focusing on fees when comparing processors: Yes, it’s important to get a good deal. But a “good deal” isn’t just a number. It’s a formula that accounts for rates and fees as well as the quality of service.

Making sense out of interchange rates

Interchange sounds like one singular thing, but in truth it’s a vast set of tables and rates that vary depending on the type of card being used, the method used to process it, and the type of business being operated.

For example, let’s say that a supermarket and a restaurant in the same town using the same payment processor each run a transaction for twenty dollars. The two businesses will pay a different rate for the same transaction amount because they’re in different industries and operate on different interchange tiers.

And if two twenty dollar transactions are run at the same supermarket, one on a rewards card, and one on a standard credit card, the supermarket will pay two different rates because of the different card types. And further, if two twenty dollar transactions occur at the same supermarket, with the same card type, but one is swiped and the other is key entered, there will be two different rates.

The basic formula for interchange is a percentage of the total sale amount plus a per transaction fee. Generally, a “rate” represents a percentage of the transaction amount and a “fee” represents a set dollar amount. Let’s break this down further using an example base rate for a fully-qualified retail transaction; which could be something like 1.51%+ $0.10 per transaction fee. The rate could increase if the transaction is downgraded to the mid-qualified rate because it was key-entered instead of swiped and be 1.80 + $0.10. And if the card is key-entered and doesn’t include Address Verification Service (AVS) or has no card strip data, or isn’t settled within the set timeframe, it could be downgraded even further to non-qualified, and cost 2.30% + $0.10.

Since interchange is set by the card networks and isn’t negotiated between the processor and merchant, SMBs don’t need to worry about getting a fair deal regarding interchange. Sometimes the processor’s fees are included in the rate formula, so it’s reasonable to ask to see those charges broken down separately from the interchange rates for comparison.

Interchange is complex and subject to change periodically. Historically it changes at least twice per year. Current interchange rates can be found on the card brand networks’ websites: Visa’s here, and MasterCard’s here.

Fraud and chargeback risk

A big reason why different cards, business types, and acceptance methods determine interchange is the risk of financial loss due to fraud and the resulting chargebacks that each factor presents. The riskier a transaction is, the more it costs. Card-present transactions where the cardholder physically presents the card for payment have a lower level of risk, whereas card-not-present transactions via phone or online sales increase risk since it’s more difficult to verify that the purchaser is the legitimate cardholder. Industries with a higher incidence of fraud or disputed transactions and those with larger per ticket amounts tend to pay more to process transactions to cover the potential financial losses the issuing bank could face.

Size and volume matters

The size and volume of a business’ average ticket also impacts the interchange rate. A business processing smaller tickets hundreds of times per day should be set up on a different tier than a merchant only processing a couple of high tickets per day. The high-volume, low-ticket merchant generally pay lower per item fees at a higher percentage, whereas the high-ticket, low-volume merchants should pay lower percentage fees and higher per ticket fees. Make sure your rate quote reflects the right tier for your business type.

Credit card processor fees

Interchange fees are just the beginning when it comes to the cost of payment processing. Credit card processors collect and pay the interchange fees to the card network but they have their own value enhancements and operating costs to cover, so they charge additional fees on top of interchange. This is where you will start to find some variation between providers in terms of costs.

The variation in costs between processors should reflect the added-value they can deliver. Unfortunately, we can’t state that as an absolute since there are sure to be some processors out there that have high fees and offer little additional value. But knowing about potential value-added features should give you a good understanding of the cost benefit ratio.

Processors that offer value on top of the basic payment authorization function earn their cut by allowing you to accept a broad variety of payment types (the more the better), providing top-shelf payment security technologies, helping you expand to additional locations, and being available 24/7 for in-depth customer support. They can also offer reporting management solutions, gift and loyalty programs, data insights, digital and social media marketing, sell-on-demand capabilities and additional services that go above and beyond basic transaction processing.

All processors are different, and there are a variety of ways that processors add fees to merchant accounts. Here are just a few:

Add on services like gift and loyalty programs and security protection

How to get a good rate

Unfortunately, it’s impossible to cite one best-case scenario for rates since every business has unique variables (business size, transaction volume, industry, card types, processing environment, etc.) that determine costs. The variability and complexity of interchange, rate structures, and pass-through fees can make it difficult for business owners to estimate or compare overall credit card processing costs between processors. The exact same rate structure and fee scenario could be a great low-cost option for one business, and end up costing a different business significantly more due to the different variables at play. Though this may appear confusing, it shouldn’t necessarily be interpreted as trickery on the part of credit card processors.

Understanding the main aspects of how pricing works and getting clear answers to your questions when you’re discussing rates can help build trust between yourself and an account representative so you can feel confident in your decision.

Free rate review

If you already have a credit card processing account, you have the advantage since you can use your current processing statement to get a good cost comparison with other providers. Always ask for a free rate review when shopping for a processor, and get at least one more review from another provider to compare it to.

If not, don’t worry. Just knowing about the potential value of payment processing, what’s available on the market, and having a general understanding about how rates and fees works will give you some negotiating power. When you know what you’re buying and what it’s worth, you’re in a great position to get a good deal.

How to spot quality and value in credit card processors

The quality of your payments service can have a much bigger impact on your overall profitability than your rates. After all, it doesn’t matter what your rates are if your system is down and you’re unable to accept payments during a rush. Be sure to factor the considerations below into your decision.

Enhancing the customer experience

Choose a company with a reputation for quality support. Look for good ratings and industry awards for consistently responsive customer support. And don’t forget to think about your customers and the experience they’ll have with your business. A quality credit card processor is just as concerned about your customers as you are.

Tip #1 Accept all paymenttypes

Make sure your customers can pay any way they want, whether it’s with a rewards card, a mobile phone, or an EMV chip card. It’s good customer service, and the more payment types you accept, the less likely you’ll be to miss a sale due to payment type.

Tip #2 Sell wherever your customers shop

The same concept applies to the various ways people shop: in-store, in-app, and online. If your processor provides an omnicommerce (aka selling on-demand) path to purchasing on all mediums, you’ll capture more revenue for yourself and lose less to competitors doing business in those spaces.

Tip #3 Speed up the checkout process

Consider a payment system that is flexible enough to bring the terminal to the customer to speed up check-out lines, or allow customers to use chip cards tableside at a restaurant. You’ll be able to serve more customers and deliver an added touch to the checkout experience.

Growing your business

Choose a payments partner with a commitment and the necessary tools to help your business succeed and grow. From gift and loyalty solutions to data insights and digital marketing, there are a lot of great technologies available to help you reach your goals.

Tip #1 Know your customers

The ability to recognize your customers, know their shopping/dining preferences, and reach out to them with special offers and rewards is an invaluable service that the right payment partner can provide. Ask potential providers about their gift and loyalty services and digital marketing solutions.

Tip #2 Leverage customer data

Rich data is a highly useful tool available from some processors. Looking beyond your own transaction data for actionable insights can help you turn that data into a strategy for growth.

Tip #3 Use social media to your advantage

Maintain a positive online profile. With the right tools, it’s easy to monitor online review sites, respond to negative feedback, and even keep pace with your competitors in terms of operating hours, specials, and discounts.

Maintaining strong card data security

Card data security is a complex topic and requires vigilance on behalf of processors, merchants, and cardholders alike. Make sure your processor has the technology you’ll need to maintain secure systems with minimal effort.

Tip #1 Use PCI compliance assistance

Achieving and maintaining PCI compliance is a great way to start securing your business against data theft. There are 12 complex steps required to achieve compliance including tasks like establishing strong network firewalls, implementing virus detection software, and closing remote access loopholes. A good processor will provide a PCI assistance program to simplify the process and help ensure ongoing compliance.

Tip #2 Protect customer data

Encryption is a crucial type of data protection that should be built into the transaction process. It replaces true card data with characters and symbols that have no value without the encryption key used by the authorization network.

Tip #3 Don’t store sensitive data

Tokenization works similarly to encryption but masks true card data so that it can be safely stored in a payment system for future transactions like tip adjustment and recurring transactions.

Tip #4 Process chip cards with EMV

EMV chip card terminals help reduce fraud by generating a unique code for each transaction authorization so that the code cannot be duplicated and used in future fraudulent transactions or to create counterfeit cards.

Further considerations

We’ve covered the big questions that most small business owners have when thinking about credit card processing services. If you’re still not sure which processor is right for you after reading this article, try speaking to someone you trust like your bank, your POS reseller, or technology consultant for answers to some of your specific questions. Or, pick up the phone and give us a call. Here at Vantiv, we field a lot of exploratory questions from novice and experienced merchants alike, and we’re happy to help you think through all your options to narrow them down.